[En] The vicious cycle of low cost

The economic decadence of the developed economies in the last two decades may have been influenced by many different factors, but there are reasons to believe that what may be called the low cost mindset must have played a major role.

For a start, low cost is unquestionably an appealing idea, which, by the way, is part of the problem, because, if it were not, the effects, both positive and negative, would have a lower impact. For a consumer, having to pay less to buy something is a compelling proposition. Why would anyone pay more if she could pay less? Spending less for the same makes people feel wealthier even if their income does not increase. Besides, low cost makes several products and services accessible to a large number of people that otherwise could not afford to buy them. Thus, low cost seems to be a perfect solution, by which more people are able to buy more of more goods and services at lower prices. It is good for consumption. It is good for the economy. It is even good for society as it may spread well being and reduce inequality. Everybody wins. No losers. Does it not seem too good to be true?

We were told that the low cost panacea was made possible because technology-enabled gains in efficiency and productivity have turned production costs down. No question that a significant progress was made in cost cutting, after many years of reengineering and lean management. Yet, competition is always tough when price is the ultimate argument. Efficiency can always be further improved but its marginal gains tend to shrink over time. So what happens when efficiency gains are no longer enough to stay competitive? Other serious cost-cutting measures must be taken.

Squeezing suppliers is definitely one option if you have the power to do so. And if you do, the cost-cutting pressure just moves up in the value chain. Some upstream players may be strong enough to acommodate these challenges, but others will be unable to cope with it and be out of business sooner or later, which will foster supplier concentration. What happens next is that the more concentrated the upstream market becomes, the more difficult it will be for you to get what you want, i.e. lower prices.The remaining suppliers will very likely be larger and stronger and less likely to give away on your demands. As with any other cost-cutting measures, you can use supplier squeeze up to a point. Trying to go beyond that point will turn against you.

Another, and not always the last, option to reduce costs, in order to keep fighting cut-thoat competitors, is to turn labor costs down. You may reduce your headcount, you may reduce the payroll by paying less, even if it means laying-off your most expensive and most qualified workers, you may move operations offshore to low-wage countries, or you may take any combination of these measures. One way or the other, it will always imply that unemployment goes up, while salaries go down, which will affect disposable income and consumption. On top of that, compulsive cost-cutting will often damage quality levels, because higher quality production factors are replaced by less expensive and lower quality ones. Lower consumer income and lower quality will cause demand shrinkage, which adds another justification to further reducing prices in an attempt to stimulate demand. And on and on...

Thus, the low cost mindset creates a never ending vicious cycle of lower prices, lower costs, lower employment, lower income, lower demand, lower prices...A never ending vicious cycle of individual and social empoverishment. In short, low cost actually ends up meaning low jobs, low salaries, low quality, low life. The irony is that many people actually felt wealthier in the beginning, i.e. before being laid-off or forced to accept lower salaries.